By Peter Martin
A High Dollar, a Healthy Economy, Low Deficits: Pick Any Two from Three!
We all might like to have: 1) A high Australian dollar 2) Close to full employment with a healthy growing economy 3) Low government and trade deficits or even surpluses. A high dollar helps us afford to buy that Korean made TV or Chinese smart phone or to go on a foreign holiday which is often much cheaper than an Australian holiday. We all would like the economy to be in good shape so that we or our family members can find well paid employment. We’d probably like low government and trade deficits (more correctly the current account deficit in the balance of payments) too. We’re told often enough how we shouldn’t be living beyond our means. So this must be a good thing. Or must it? Are all three even possible simultaneously?
If we have to choose just two which one should we leave out? There is no simple answer but if we better understand the way our economy works we will at least know what the options are from all political perspectives. Including the second option, of a healthy economy, should be a “no-brainer” for politicians across the entire political spectrum. Businesses need a buoyant economy to make profits just as workers need a buoyant economy to find decent and well paid jobs. But is it? The recent news is that Australian unemployment has just risen to 6%. Some economists clearly don’t think the Government knows what it is doing with its attention focused solely on the budget deficit. The quest for a balanced government budget seems as distant a goal as ever, but the connection to that other largely forgotten deficit, in trade, is rarely made. Previous generations did not share our relaxed attitude to the imbalances we see in international trade. The monthly trade figures were a regular and prominent feature of our business news, at one time, but we have to look much harder to find those same figures now.
They well understood, what we seem to have forgotten, that if any particular country, as a whole, has a net deficit trading position with the rest of the world then either the government of that country, or the inhabitants of that country, has to fund that deficit by borrowing. In other words, the internal deficits run by governments, and the extent of the private sector debts which can accumulate in the economy, are directly related to the external deficits caused by a trade imbalance. We can see that countries such as Germany, Switzerland, and Singapore which run large trading surpluses do not have any of the public or private sector debt problems which we see in the UK or USA which run large trading deficits. Unfortunately, though, the solution to world debt problems cannot be for everyone to run a trading surplus! If we do wish to ensure the third option, of low deficits, is included in our choice we need to understand that both government and trade deficits have to be kept low.
Transferring the burden of debt, as seems to be the wish of ALP neoliberal economists too, necessary to sustain the current Australian trading imbalance, from government to the private sector is going to do less than nothing to solve the economic problems of the country. If government wishes to reduce its deficit, without crashing the economy by imposing an unrealistic debt burden on everyone else, and at the same time creating unsustainable asset price bubbles, it has to acknowledge that this can only be done by reducing the trade deficit. It has to start to tackle the problem from both ends by nudging down the value of the dollar a little more. Including the low deficit option means we have to then choose between having a high dollar and a healthy economy. We can see for ourselves what happens when a country like Greece is stuck with a currency which is too high to suit its economic capabilities and yet it is forced to attempt to balance its books. The economy crashes! We have seen the dollar fall recently but has it fallen enough? Or, we can choose a high dollar, a healthy economy and have a more relaxed attitude to the twin deficits.
There are many economists, who I personally would agree with, who present a good case for selling as much debt (government bonds) as is possible and recycling the proceeds back into the economy with increased deficit spending. Some debt can also be sold to the central bank (RBA) in what has come to be known as People’s Quantitative Easing. Providing inflation is kept under reasonable control there should be little or no problem. We can also have a more relaxed attitude to the build up of private debt (if we know what we are doing!), but we should appreciate the difference between the two types.
Government debt, unless it is in some foreign currency, doesn’t have to be repaid in the same way as private sector debt. The accumulation of too much private debt can lead to economic busts to follow the initial boom created by the increase in bank lending. The former Liberal Treasurer Peter Costello likes to boast of his economic prowess by having ‘delivered’ a budget surplus in the pre GFC period. Simply created by allowing too much private sector borrowing, unfortunately! Many economists, such as Steve Keen, point out that the mainstream of the economics profession seems quite oblivious to the problems of stop-start bank lending. The acceleration produces the boom. The sudden deceleration, when we later have the inevitable ‘credit crunch’ produces the slump. We know from our own experience that Steve is absolutely right about this, so why can’t the mainstream change their models to reflect reality?
Most of this posting, so far, is entirely apolitical in nature. The same economic constraints apply whatever the political complexion of the society or economy involved. It is natural we might have different ideas and opinions over the ideal size of government. It is fair enough to argue for a more socialist approach to the distribution of available wealth and income or a more conservative approach. What is not fair enough, though, is for the political right or neoliberals (who are unfortunately not confined to the Australian Liberal and National Parties) to wreck public services and our economy, for some nefarious purpose, or in some misguided attempt to reduce the government’s deficit, by cutting government spending and raising taxation without taking into account everything else that changes when they do that. All they’ll do is crash the economy!
Judging by the economic storm that is brewing, the powers-that-be haven’t learned from past mistakes and it looks very likely we are seeing the start of yet another very severe financial crisis. Thanks to the boom in the Chinese economy, Australia was very fortunate to escape relatively lightly after the 2008 GFC. Will our luck hold out for the next time?
Peter Martin blogs on his own site; Modern Monetary Theory: Real Economics
